Circassia Group CIR
June 08, 2020 - 4:08am EST by
2020 2021
Price: 0.26 EPS 0 0
Shares Out. (in M): 377 P/E 0 0
Market Cap (in $M): 96 P/FCF 0 0
Net Debt (in $M): 1 EBIT 0 0
TEV ($): 98 TEV/EBIT 0 0

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Circassia has the potential to double over the next three years with very little risk to the downside. With an owner led board and highly incentivised management team, the company's market leading testing and diagnostic business has the potential to continue growing sales, at high-teens to low-twenty growth rates, at attractive operating margins and high returns on invested capital. Value should be realised by the sale of the company within three years when management's share options vest at 62.4p vs a 27p current price.


Investment thesis summary

There is a good business that has been mismanaged and masked by a poor business

  • The business currently has two operating segments, NIOX a diagnostics business for testing FeNO  (fractionally exhaled nitric oxide) and COPD which has been disposed of to AstraZeneca significantly reducing risk to the investment case. The business is now in a net cash position with attractive growth

  • The NIOX asset is underappreciated and has been mismanaged. Operating a razor-razor-blade model with 85% reoccurring revenues, potential operating margins between 15%-20%, high asset turns and low capital expenditure requirements result in a high return on invested capital. This will receive the full focus of the management team going forward. 


Management and the owners who installed them are high quality and aligned with share holders

  • The CEO and CFO have both been brought in by one of the key shareholders, Harwood Capital, to focus on growing the NIOX business. Harwood have a long track record that follow a similar playbook of taking significant stakes in mismanaged businesses with strong potential, bringing in a trusted management team and realising value. The CEO and CFO most recently sold Bioquell, where Harwood owned 30%, to EcoLab in 2018. Harwood entered Bioquell at 120p per share, tendered half at 200p when the company sold a single division at a premium to the value of the entire company and sold the remaining shares for 590p when the company was acquired by Ecolab, ultimately realising a more than 3x return.

  • Circassia's CEO and CFO's only significant source of remuneration is in the form of nil cost share options with a strike of 62.4p within the next 3-years. This provides strong incentive to sell the business at a premium to the strike price within that time

  • A sale to another company would achieve scale and cost savings through synergies, specifically by leveraging the sales force across additional products and through shared corporate costs leading to margin expansion

  • Insiders are buying shares at current levels. The management team bought half of their after tax salary in April post a black out period and Harwood increased their stake to 12% from 9%. In addition, the company has secured a commitment for a further £5m of equity through shares it can raise from Harwood and another shareholder which would be equivalent to 13% of their current stake. This is indicative of the confidence Harwood continues to have in the business


The valuation is attractive

  • The market for FeNO testing in the US alone is currently worth ~$200-300m and Circassia could take between $40m - $115m of this. This compares to current sales in the US of $8.7m providing an opportunity for a long runway of continued growth

  • The NIOX business has 70%+ gross margins and is growing sales at 15%+ but is still sub-scale. This leads to elevated sales and marketing expenses as a percentage of sales and understates the earning potential. Margins should be higher than the 15% management expect to achieve in the short-term

  • Backing out the implied valuation from the 62.4p option strike and assuming 15% sales CAGR from £36.4m in FY19 to £52.6m in FY22 the business would be sold for 4.8x trailing sales or 4.2x forward sales. On an EV/EBIT basis the one-year forward EV/EBIT in 2022 would be 22x. This is attractive given the growth potential and relative to peers in the testing and diagnostic space


Thesis point 1 - management and the owners who installed them

The parties involved in this situation are critical to the thesis therefore I believe we should begin with introducing the owners and the managers they have installed.


A filing released in December 2019 showed Harwood Capital, a $1bn AuM small cap activist investment fund, took an 8% stake in the business. Around the same time, it was announced that the CEO was to be replaced by Ian Johnson. This was no coincidence.


So who is Harwood and why should we care?


Harwood Capital's main fund North Atlantic Smaller Companies Investment Trust runs $590m in AuM and as at 02-28-20 had an annualised return of 14% since the early 1980s. In their own words their investment strategy is:


"Hands on fund management. The investment strategy is based on a pro-active, event-driven investment style where shareholder value is maximised through specific re-structuring or financial re-engineering within an investee company. Although the Harwood Capital team is usually the single driving force behind the restructuring of the business, they are sometimes joined by other shareholders who share a similar investment approach towards the prospects for the company in question."


Effectively this playbook is being executed in this situation and we can look to a number of recent successful investments in the Harwood Portfolio that I have followed over the years including Augean (AUG LN) and EKF Diagnostics (EKF LN). Both have been multi-baggers once Harwood took significant stakes and changed the management teams.




Harwood takes a 17% stake in September 2017 and after receiving a board seat helps replace the management team in October 2017.


EKF Diagnostics


Harwood buys a 19% share in March 2016. In April 2016 becomes non-executive chairman and assists in leading the company


Who are the current management team and what is their background?

The management team Harwood have installed are CEO Ian Johnson and CFO Michael Roller. Mr. Johnson had previously founded Biotrace International plc, a provider of rapid microbial testing systems and reagents, where Harwood had been a majority shareholder and was sold to 3M in 2006. Since that time Mr. Johnson has been the Life Sciences advisor to Harwood's private equity arm. He is also currently involved in two Harwood Capital portfolio holdings, as chairman of Redcentric plc and a board member of Ergomed. Most recently, Mr. Johnson had been the CEO of Bioquell plc, where Harwood owned 30% of the company and was sold to Ecolab in January 2019.  MR. Roller worked alongside Mr. Johnson at Bioquell in the CFO role. He has experience running small companies. Prior to joining Bioquell he was CFO of Corin, a small cap hip and knee replacement maker sold in 2013 to PE.


What happened at Bioquell?


Harwood began purchasing shares in Bioquell in March 2012 and in December joined the board with a 22% stake at an average price ~120p a share. In January 2014 Michael Roller is appointed group finance director. Harwood up their stake throughout the year and in late November own ~30% of the company. In March 2015 a division of the company is sold for £44.5m which is greater than the £35m market cap it traded for before the announcement. Following a strategic review, in April 2016 the decision is taken to return £42.7m to shareholders through a tender offer to buy back half of the company's outstanding shares at 200p. In June Ian Johnson joins as non-executive Chairman and in August is appointed executive Chairman. Over the proceeding years the business is dramatically simplified and refocused with sales growing in the low double digits and EBITDA margins expanding from 16% to 21%. In November 2018 Ecolab offer a 40.5% premium for the shares totally £141m or 590p a share. Harwood doubled their money on half their stake by tendering at 200p three years after purchase and earned 26% CAGR on the remaining position through the sale to Ecolab.


Why the sale of Circassia within the next two and half years looks like the goal

Given the track record of the management team and Harwood, the sale of the company looks like the most likely exit route. The management incentive compensation structure also points to this.


Remuneration (000's)

Prior CEO (2018)

New CEO (2020)

Prior CFO (2018)

New CFO (2020)

Base salary





Total compensation






There new CEO and CFO will only receive a fixed base salary with no entitlement to a bonus. Instead they have been granted 6m and 5m nil cost options respectively with a strike of 62.4p. This would result in a payout of £3.7m and £3.1m respectively or 12x and 31x their base salaries. The shares vest and become exercisable 3-years after being granted on 12/19/19. They are in the money when the share price reaches 62.4p or from a liquidity event occurring at a price above the strike. The strike price was set as 3x the avg closing price of the shares 10 days prior to the grant date.


Management and Harwood have purchased shares on the open market

In late April, Harwood upped their stake to 12% and the management team bought half of their after tax salary in shares post a black out period working on disposing the COPD business which I explain below. In addition, Harwood participated have committed to participating in an equity facility to raise capital from Harwood and another shareholder by November at the lower of 24.6p and the prevailing market price. Harwood's commitment would be for a further £1.5m or 13% of their current stake. Taken at face value this seems indicative of Harwood's confidence in the business despite recent developments. 


Conclusion of thesis point 1

To summarise, Harwood who specialise in this type of situation have taken a significant stake in the business, installed a capable set of managers and incentivised them to sell the company within three years at >2x the current price.


Thesis point 2 - NIOX is a good business, but has been mismanaged

Looking at the company a few months ago it was not immediately obvious why Harwood et al was involved. Circassia was loss making and had a £150m in debt. However, since joining, the management team have reshaped the cost base, disposed of a loss making business and can now focus on NIOX. Below I lay out a timeline to explain how we got here and why the NIOX business was neglected and what I think the new owners and management team see in it.




  • Circassia began in 2006 as a company commercialising intellectual property from Imperial College London and other leading UK universities. As a private company it received early backing by Neil Woodford (yes that Neil Woodford) for development of allergy vaccines. It listed to much fanfare in 2014 at 300p a share with a market cap of £600m and was billed as the next Shire. However, it was all downhill from there. 

  • In 2015, Circassia diversified into asthma and respiratory assets acquiring two companies Aerocrine of Sweden (which had the NIOX product) and Proxonix of the UK for £139m and $100m respectively in all-cash deals by issuing shares.  

  • In 2016, prior to the Brexit vote, the company's phase III drug trial for cat allergies failed after not demonstrating efficacy above a placebo. The shares fell 65%.  

  • In 2017, the remaining allergy assets were written-off as other phase III trials failed. The company then acquired the US rights to AstraZenca's COPD drugs: Tudorza (approved) and Duaklier (in phase III), essentially dry powder inhalers. This is a highly competitive and commoditised area of the market.   

  • In 2019, the company wrote off the Proxonic assets purchased in 2015 and in January entered an agreement with AIT  for a product called LungFit which delivers nitric oxide. In December 2019 BeyondAir (previously AIT Theraputics) announced it was withdrawing from the agreement for material breach.  

  • Along the way the Woodford debacle occurred leading to an unwind of Woodfords ~30% position in Circassia.  Clearly this was an imperative step for today's opportunity to exist.  

  • In December 2019 the company was effectively left with the AstraZeneca COPD drugs and the NIOX asset. Overall it was loss making and saddled with debt. Hardwood Capital bought an 8% stake and replaced the management team.


Fast forward to today. On April 9th the company announced an agreement with AstraZenca to dispose of the COPD business and cancel the $150m in debt it was owed. AstraZeneca will retain its 18.9% holding in the company which it had previously been granted as payment for the COPD assets. The result is a business with £6m in net cash and a highly attractive business in NIOX. This was a significant achievement by the management team as the COPD business was under significant pressure from low levels of prescription sales in a very competitive area of the market. One can imagine that in order for Astra to effectively take back the business and forgive the debt, Circassia management would have laid out a very credible investment case for the NIOX business that would benefit Astra's upon sale of the business.


So what is NIOX? 

The business sells a device and the subsequent testing kit to test FeNO levels. I refer you to the following PDF for a fuller explanation, but essentially nitric oxide has been shown to be a marker for airway inflammation in asthma. This is important because asthma is a combination of both inflammation and constriction. Inflammation is treated with steroids and constriction with bronchodilators. If a test subject doesn't have inflammation, i.e. if FeNO is low, then they don't need steroids. Currently most physicians only measure constriction using Spirometry when they should really be measuring inflammation using FeNO. Aside from diagnosis of asthma, FeNO monitoring is also useful in steroid responsiveness and dosing of inhaled corticosteroids (ICS), monitoring asthma control, medication adherence, and asthma biologics.


Therefore a large proportion of asthma patients are misdiagnosed and face side effects from being prescribed steroids, being both increased cost and poor patient outcomes. The high costs of treating asthma are well documented and run in the multiple tens of billions of dollars in the US alone. Accurately measuring FeNO is beneficial both to the patient as well as the parties paying for respiratory treatments, i.e. insurers. Therefore, as discussed below most insurers in the US have recognised the benefit and have deemed testing for FeNO as medically necessary and will cover the cost of testing.


Physicians are the final step to FeNO gaining wider adoption. To this end in the US, on average, plans reimburse $26 per test for Commercial, $20 for Medicare, $15 for Medicaid (CPT code 95012). In addition, physicians can bill additional codes for the mouth piece at $3 and for the time taken to perform the test which is a minimum of $20. Therefore, physicians can bill upwards of $38 ($15 + $3 + $20) for a test that they would otherwise not have performed. This is a win for all parties involved: patients can be diagnosed properly saving both themselves and insurers costs of misdiagnosis, and physicians receive an additional revenue stream they would otherwise not have had if solely performing a Spirometry test.


Why is this a good business? 

First, ~85% of revenues are reoccurring in the form of test kits that sell for ~$10 each with patients requiring 2-3 tests a year. The remaining revenue come from device sales that retail for ~$2,500. Blended gross margins are ~70%+ leading to attractive run-rate EBIT margins. In the short term the business will operate at 15% margins as sales and marketing spend will remain elevated to drive sales. R&D needs are limited and central costs are being cut and will remain relatively fixed. Capital intensity is low as the devices and test kits are manufactured by Panasonic and the company has a very tight working capital cycle. High margins and low level of capital requirements lead to very attractive incremental returns on invested capital.


Sales have grown at 18% CAGR since being acquired in 2015. FY19 sales were £34.6m up 26% YoY broken down as follows:


Sales (millions)














*includes France, Italy and 40 other countries


How the business was mismanaged

Essentially the management team was stretched and not wholly focused on NIOX. It speaks to the strength of the business that sales grew as they did. However, fumbles such as changing the distribution model in China in 2018 led to no sales growth. The US sales force also appears to have been poorly organised and lacking direction. It is clear that the cost base was bloated as evidenced by the significant cost cutting measures taken by the new management team (described in the valuation section).


Reimbursement status in key markets

Clearly the driver of sales is the usage of the tests. This is a function of physicians being aware of FeNO and getting someone to pay for it, i.e. reimbursement (% of covered lives and level of per test reimbursement).


Beginning with the US, in 2011 American Thoracic Society (ATS) guidelines were published demonstrating clinical utility of NIOX devices and insurance coverage in the US reached 39%. Today the company have coverage for about 79% of insured lives (Commercial, Medicare, and Medicaid combined)  where payors designate the test as "medically necessary". Cigna and Anthem are two major commercial plans that do not cover FeNO today, but Circassia are actively working with them.


In China, currently 16 provinces covering a population of >720m have some level of reimbursement which varies from 65-100% coverage. The price of this reimbursement varies by province between 150 to 300 RMB (£17-£33) per FeNO test. Of the total installed hospitals, currently 55% have some level of reimbursement in place.


In Germany the current business is just from the private pay segment of the market (10% of the total market). There are plans in place to gain reimbursement on the back of Sanofi gaining reimbursement for FeNO with the launch of their new biologic Dupixent. This reimbursement would initially be limited to severe asthma patients, the plan is to work with key opinion leaders (KOLs) and the G-BA (public insurance decision maker) to expand this. Expected timelines on this are Q3 2020.


In France, Circassia are currently working with a leading KOL who with the support of the French respiratory society have submitted an application for reimbursement to the public health authorities. It is my understanding that the HAS report of the clinical assessment and recommendations have been sent to UNCAM (National Union of Health Insurance Funds). UNCAM have conducted a full medical economic evaluation in order to determine pricing for the medical act. In addition, Sanofi have made an application for their new biologic Dupixent which will strengthen Circassia's application.


I expect the management team to address the market publicly on a call for the first time in early June where I believe they will lay out an "investor day" type of presentation to communicate their plans to the market on what they are going to do differently and what their sales strategy will be. Currently there is some debate about whether they will continue to use a direct/indirect/hybrid model in their current markets. In my discussions with them there were basic things that the prior management approached incorrectly such as being too focused on achieving a high ASP for the device instead of trying to drive the repeat sales through tests and poor aftersales care as well as not focusing on high volume users.


Conclusion of thesis point 2 

In summary, this is a product that has the potential to improve patient outcomes through better diagnosis, measure their progress and treatment adherence, save payors significant amounts of money through misdiagnosis and generate good fees for physicians. The business proposition is strong with 85% reoccurring revenues, a good runway for growth into existing markets and high margins and low capital requirements. It historically did not receive the required attention from the management team to properly drive sales and keep costs under control.


Thesis point 3 - valuation is compelling

How big can this be? Using the US market as it is the most developed as an example: there are 26m asthma sufferers in the US of which 9.6m have been identified by the company as a target market. This market focuses on specialists (allergists and pulmonologist) rather than primary care professionals. Assuming a patient will be tested on average 2-3x a year at $10 a test the total opportunity is $192m - $288m. Further, assuming the market share of any one company is 15%-40%, the revenue potential for that company is $43 - $115m assuming no further market growth. Circassia currently have sales of £8.7m or $11m on a 1.3 exchange rate. Therefore, there is the potential for continued growth in revenues in the specialist market alone before even contemplating other regions or the primary care segment of the market which the company estimates is 3x larger.


In terms of competition, currently, the only other company to have FDA approval for a FeNO device in the US is Spirosure, but it is private. Competition is nascent in the EU/UK with Bosch having a device and some other smaller companies that have minimal sales. It is fair to say that currently Circassia is the only real contender at present and even accounting for potential new entrants the size of the market is not currently a limiting factor.


Given the priority is to drive sales growth, the majority of the gross profits will be spent on sales and marketing (S&M). In discussions with management they have indicated that they can reach 15% EBIT margins at a level of £40-42m vs £34m in FY19. As they scale they will eventually be able to dial back absolute S&M spend leading to greater margin expansion. Management have already made significant cost savings guiding to a reduction in S&M spend of £4.3m (18%) in 2020 as well as £2.4m in corporate costs already achieved and a further £1m expected for the remainder of the year and £0.2m in 2021.


The table below is a pro-forma income statement excluding the other divisions in all areas except central costs. Going forward these would be wholly attributable to the NIOX business, but the historical figures would have been impacted by the other divisions. I have taken a more cautious view on EBIT margins as I am not entirely sure how much further cost reduction will be taken and to what degree the sales force will remain direct vs indirect in certain markets. Nevertheless, assuming the company is able to tap into the opportunity, margins should expand to an attractive level once it begins to scale.



Furthermore, sales leverage would greatly improve within an organisation with more than a single product and help spread central overheads. My feeling is that the thesis Harwood et al came into this with was to divest the onerous AstraZeneca COPD segment, demonstrate proof of concept with the a focused NIOX business and sell the company to a larger organisation that can derive the necessary synergies through scale. A potential natural buyer in my view would be a Spirometry company as the device would be complimentary and fit well within the sales force. Alternatively, it could be to other FeNO competitors who wish to gain scale quickly.


What do you pay for a business with 85% reoccurring revenue with a decent runway of growth followed by GDP+ mature growth with a minimum of 15% operating margins generating high levels of returns on invested capital?


The company was bought from Aerocrine for 9.5x 2014 trailing sales of £14.7m. Once it was acquired by Circassia we lost the detailed disclosure of installed devices and testing volumes, but prior Aerocrine filings show the global installed devices grew at a 23% CAGR from 2010 to 2014 to over 7k units and test volumes grew at the same rate to 2.5m in 2014. Suffice to say I believe 15% annual revenue growth is well within reach which should put them at £53m of sales in 2022 and £6.75m of EBIT.


If the company is sold at management's option strike price of 62.4p (ignoring any cash to assume EV= market cap and adjusting for dilution from the share options and full £5m equity raise), the 2022 sales estimate implies ~4.8x trailing sales or 4.2x the 2023 sales if grown at 15%. An EV/EBIT basis would imply 37x FY22 or 22x FY23. These figures are below or in-line on a forward basis with other high reoccurring revenue testing and diagnostic businesses (I recognise these are not perfect peers, source is BBG on next year basis). Further, Circassia has higher sales growth potential and a margin expansion story.





Sales execution - the success or failure of this thesis will depend on the ability of the management team to drive sales. Their track record has been strong in this regard and they have made a good start. Since joining a few months ago they have already separated from the AZ business and restructured the cost base. I would expect management to deliver a full strategy update to the market in June along with the full-year results.


Competition - I don't see this as a significant risk to the thesis as currently NIOX is the market leader and the market is still in its infancy.


COVID-19 - Post the AZ separation the company should be in a £6m net cash position. Sales have been impacted as testing declined. In addition, to the cost base being restructured they have been cutting back on additional T&E and marketing. Assuming some return to normalcy within 6-months they will avoid an equity raise. Otherwise they will have to do a small one to bridge through the period. This funding has been secured on June 2nd via Harwood and one other significant shareholder for £5m which can be called upon by November and extended if agreed by the parties.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Market update in June which should set the direction for the company under the newly formed management team and board.

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